RBA takes away Joe Hockey’s pain

The Federal Government’s budget outlook has just been substantially changed by the Reserve Bank of Australia, because the economy is doing substantially better than the Treasury was betting just eight weeks ago.

The Reserve Bank of Australia's latest forecast indicates the Australian economy turned the corner in December. Photo: Louie Douvis

The latest RBA statement on monetary policy cautiously upgrades its forecasts for the Australian economy. The bank now expects 2.75 per cent real GDP growth this financial year instead of the 2.5 per cent central forecast it made in November.

More importantly, growth for the year to June 30, 2015 – what Joe Hockey will be concentrating on in his first budget – has been increased to 3 per cent.

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Given that the Treasury Secretary, Martin Parkinson, sits on the RBA board and the two institutions’ economic forecasts tend to agree with each other, several billion dollars worth of pain promised in Hockey’s December mid-year-economic and fiscal outlook presentation has been revised away.

The accompanying graphs tell the story of an economy that turned the corner in the December quarter.

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In November, the RBA thought the domestic uptick wouldn’t be able to counter the fall in resources construction until early 2015 – but it’s already happening.

And the RBA is positively optimistic about the prospects of 2015 with growth rising to an above-trend rate in the next financial year.

Some of the improved outlook comes from the weaker Australian dollar – although that comes at the cost of higher inflation. The RBA is expecting underlying inflation to hit 3 per cent in June before easing a touch to stay within its target range.

The rest of the growth though confirms the steady diet of improved statistics and surveys, none better than this week’s retail sales, balance of trade, business conditions and confidence and building approvals trends.

After their usual caveats and concern about the fall in resources investment, the RBA mandarins put it thus:

“A number of indicators, however, suggest a gradual increase in growth over time. The depreciation of the exchange rate should provide some additional impetus to activity in the traded sectors of the economy. Survey measures of business conditions moved to above-average levels late in 2013. Retail sales and the Bank’s liaison point to a pick-up in household consumption growth in the December quarter and measures of consumer sentiment remain a little above average levels, despite easing somewhat from a few months ago. Leading indicators suggest that dwelling investment is likely to have increased in the quarter and will grow further over the coming months. Strengthening conditions in the housing market more generally are evident in further increases in housing turnover and prices. Trade data imply strong growth of exports in the December quarter, boosted in part by new resource projects coming on line.

Several billion dollars worth of pain promised in Hockey’s December mid-year-economic and fiscal outlook presentation has been revised away.

“Overall, growth is thought likely to strengthen a little in 2014, though to a pace that is still a little below trend. It is then expected to pick up further to an above-trend pace by 2015/16 . (This outlook is a little stronger than it was at the time of the November Statement, primarily owing to the lower exchange rate, which is expected to boost exports and restrain imports (to the benefit of domestic production). The outlook for the various components of domestic demand is little changed.

The domestic key remains the increase in dwelling investment, which was downgraded by Treasury in December from 5 per cent growth this year to just 3 per cent. Somewhere in Canberra, economists will be busily adding a few points back on.

Says the RBA: “Dwelling investment is expected to grow quite strongly over the forecast period. Building approvals have increased sharply in recent months and other forward-looking indicators, such as loan approvals and first home owner grants for new construction, remain at relatively high levels. Conditions remain supportive of dwelling investment, with very low interest rates, rental yields around the average of the past decade and government incentives for first home buyers that promote the purchase of new dwellings. Stronger conditions in the established housing market, including a rise in housing turnover, are also expected to support renovation activity, which to date has been quite subdued.”

The improved growth forecast, however, isn’t enough to stop unemployment edging up a bit more, or to stop wages growth continuing to fall.

In a par that should be enough to embarrass some who’ve made shrill statements about wages explosions lately, the RBA says:

“The increase in spare capacity in the labour market over the past year or so has been accompanied by a decline in various measures of wage growth to historically low levels. Reflecting elevated concerns of households over job security, relatively low inflation expectations and pressures for firms to contain labour costs, the forecast profile for wages has been revised a little lower over coming quarters. In the public sector, fiscal restraint is expected to contribute to very slow growth in wages, as reflected in recent enterprise bargaining agreement outcomes. Private sector wage growth is expected to pick up somewhat from the middle of 2015 as the labour market recovers. However, it will take some time for spare capacity in the labour market to be absorbed and so wage growth is expected to remain below its decade average.”

The inflation downside is acknowledged, but it’s not enough to frighten the RBA horses yet.

“Underlying inflation is expected to reach 3 per cent over the year to June 2014, about ½ percentage point higher than forecast in November. This upward revision reflects the higher-than-expected inflation reported for the December quarter – which is assumed to persist somewhat into early this year – as well as the effect of the further depreciation of the exchange rate since November. Given the slow growth of wages and the limited extent of domestic cost pressures more generally, year-ended underlying inflation is expected to ease back later this year. Headline inflation is forecast to reach 3¼ per cent over the year to June 2014. In addition to the same factors influencing underlying inflation, the upward revision to headline inflation reflects the increase in the price of tobacco in December. As this and the large rise in fuel prices in the September quarter drop out of the year-ended rate, headline inflation is expected to fall back. Over the forecast horizon, inflation is forecast to be consistent with the target.”

Combine that outlook though with the forecast of growth above trend in 2015-16 and it’s obvious stimulatory monetary policy won’t last.

So enjoy your present low interest rates. If the RBA is right, if the outlook for the Australian economy is as good as its modelling suggests, expect rates to be tickled a little higher early next year.

There are of course many risks to the forecast, as demonstrated by the graph’s wide band of probability measurement. Among the risks, there’s one that should weigh heavily on the Treasurer.

“The fiscal consolidation foreshadowed by state and federal governments implies the weakest period of growth in public demand for at least 50 years. With below-trend growth in the economy, it is possible that governments will not restrain spending growth to the extent assumed. Alternatively, budget deficits at the federal level are projected to be noticeably larger over the forecast period than expected at the time of the November Statement, which could lead to greater spending restraint.”